Chip stocks, once a hot favorite among investors, are doing poorly this year . The iShares Semiconductor ETF is down around 31% so far this year – lagging even the broader market. The S & P 500 has tumbled around 17% year-to-date. But BofA says that despite consumer demand remaining under pressure, the “bull case for semis is also compelling.” In a Nov. 10 note, the bank listed a few factors such as high profitability, with more than 20% free cash flow margins, high entry barriers to the sector, and it leveraging “key mega trends.” Semiconductor sales could also rebound in the second half of 2023, BofA predicted. Some factors that could drive up chip demand include reshoring of semiconductor manufacturing globally — increasing demand for new equipment, and government investment such as the U.S. Chips and Science Act. Here are some themes that chip stocks could ride on, says the bank, which also picked names to buy. Cars BofA says it believes every car will “look like a premium [electric vehicle],” implying a doubling of chip content. “Supply constraints are bringing automakers and chip suppliers strategically closer, with better long-term planning and stronger pricing,” it said. BofA’s stock pick to play this trend is ON Semiconductor . The cloud The bank says that while cloud capital expenditure remains under pressure in the near term, it believes chip stocks “remain ideally positioned to benefit from the exponential growth in computing complexity required for [artificial intelligence] and high-speed networking.” BofA says demand for public cloud services is set to nearly triple to $300 billion by 2026. It says that’s set to benefit Nvidia – the bank’s top pick, as well as Advanced Micro Devices . Cash flow consistency Consolidation in the semiconductor industry, as well as high entry barriers is enabling “stronger for longer” pricing trends, with return of free cash flow, the bank said. BofA picked these stocks that it said have “best-in-class” 30% free cash flow margins, with 1.8% dividend yield: Analog Devices – its top pick, and Broadcom . Compelling valuations The bank says semiconductor capital equipment stocks “provide an ideal mix of compelling valuations,” with about 14 to 15 times forward price-to-earnings. It’s raising its price targets for U.S.-based KLA – its top pick, and Applied Materials .
